Revenue-Based Financing – A Primer

The Indian Startup Ecosystem

The startup ecosystem in India has been witnessing explosive growth, with a record number of new businesses coming to life in the past 5 years alone. Led by rapid digitization and the ever increasing avenues to unlock the India consumer story, India has emerged as the 3rd largest startup ecosystem globally, with 83 unicorns plying their trade across various sectors. While the country’s startup engine accelerates at breakneck speed, the potential for further value creation remains immense.

India’s GDP per capita continues to be one of the lowest in the world, and if it is to achieve a semblance of parity with its international peers, a bulk of the heavy lifting will have to be done by localized entrepreneurship. This translates into a massive opportunity for startups, with the unlocked value resulting in enhanced standards of living, upskilling, and wealth creation across the board.

Under the government’s Startup India program, 63,000+ startups have been officially recognized, and there are undoubtedly thousands more waiting in the wings. On average, 2,000 startups are being recognized on a monthly basis under the program.

Startup funding too, has bounced back in a spectacular manner post the Covid-induced slowdown. 2021 was a stellar year, with the $42bn raised eclipsing funding from any of the prior years. The India story has well and truly arrived.

This explosive growth has brought into renewed focus that one key ingredient entrepreneurs need to turn their ideas into sustainable, value-creating businesses – capital.

Startup Funding Options and Challenges

While the funding ecosystem is rapidly expanding, the primary ways for any founder to fund the initial runway remain the same, each with its own set of considerations.

• Self-funding – The median age of an Indian founder is reportedly 27, and he or she is unlikely to have vast pools of accumulated capital to fund and scale a business.
• Bootstrapping – Startups, tend to establish a stabilized cashflow and meaningfully positive unit economics over time, so growing the business with its own cash may not be optimal. Secondly, hitting scale through the desired network effects may be difficult to achieve only through organic cash.
• Bank Debt – Startups tend to get overlooked by traditional sources of debt and working capital such as banks and NBFCs, who favour businesses with steady cashflows, positive earnings, and assets to collateralize. Today’s digital-first, asset-light startups rarely fit the bill.
• Angel Investors – Securing angel funding is a great way to setup the initial runway, but is often expensive, with founders having to give away 15-20% of their equity stake. Secondly, angel investments are often facilitated through lesser formalized networks, which may not be accessible to all founders.
• Venture Capital – Venture Capital is a powerful tool, but it too requires founders to part with a sizeable equity stake early on, and compromise on executive control. Additionally, VCs tend to prefer market disruptive ideas with potential for exponential growth, and not all entrepreneurial ideas fit this criterion. Seeking VC can also be a time-consuming process, lasting typically for 3-6 months.

The Case for Revenue-Based Financing

These challenges have created the need for a more flexible type of capital, which –

• Is easy to access and aligns to a startup’s growth trajectory
• Recognizes the variability of its operations and enables repayment flexibility
• Can be quickly disbursed to address immediate cashflow requirements
• Caters to asset-light businesses and does not require collateralization
• Is non-dilutive in nature and enables the founders to retain control

In recent years, a new class of financing has emerged, Revenue-Based Financing (RBF), which addresses some of the key pain points faced by entrepreneurs while raising capital. Revenue-Based Financing, is a form of raising debt capital from investors who receive a percentage of the enterprise's ongoing revenues as repayment, until a fixed multiple of the capital is repaid.

What are the key benefits of Revenue-Based Financing to an entrepreneur?

• Payment flexibility
• Aligned to the company’s growth
• No dilution
• Complete control
• Lesser time to disbursement
• No personal guarantees or collateralization
• Lesser expensive than equity
• Profitability not needed
• Minimal credit requirements

Below is a comparison of RBF against other forms of financing

Who is it available to?

Revenue Based Financing is available to a wide variety of businesses across sectors and lifecycle stages. A pre-requisite though, is that the business needs to be clocking revenues. Typically, companies with the following attributes stand a good chance –

• Steady recurring revenues
• High to moderate topline growth rate
• Positive unit economics
• Low COGS and healthy gross margins
• Digitized banking, finance records, and digital marketing platforms

The repayment for RBF is made as a percentage of the company’s revenues, and the investor therefore needs to ascertain that repayment is plausible through a healthy gross margin. Good margins also ensure sufficient cash is leftover post repayment to fund the company’s ongoing operations and growth. Such startups tend to be found in sectors where recurring revenues and healthy margins can be established early on, such as –

• D2C, consumer oriented e-commerce
• SaaS or subscription-based businesses
• EdTech

It is best suited to digitally-oriented startups which can realise revenues without falling into the classic working capital trap of long receivable days. Typically, startups seeking RBF will be in their nascent stages, ranging from having raised no capital up to a Series A round. Equity funding also remains an option post RBF, as seen in the summary below of the capital-raising routes.

 Source: Lighter Capital, The Rise of Revenue-Based Financing

The RBF landscape is rapidly evolving, and conventional businesses willing to pivot distribution channels online, will find themselves increasingly being accepted by RBF investors. QSR chain Charcoal Eats recently secured a crore in revenue-based funding, while furniture maker Transteel raised 4 crores through RBF.

Who is currently providing RBF?

Revenue or royalty-based financing has been an accepted form of funding for a while, but it’s seen accelerated growth in the last 5 years. Globally, the RBF market accounted for $901 million in 2019, and the industry is projected to grow at a staggering 61.8% CAGR to $42 billion by 2027.

Internationally, North America is the largest market, with major players such as ClearCo and Pipe already established as unicorns, and others such as Jeeves, Settle, and Kapitus following. ClearCo alone has invested $2.5bn+ in 6,500+ companies as of 2021. Europe’s largest players include Germany’s Re:cap, Spain-based Capchase, and the UK’s Forward Advances.

Closer to home, the Indian RBF market has gathered significant momentum, with startups such as Klub, GetVantage, and Velocity quickly establishing themselves as frontrunners. Since their founding in 2019, Klub and GetVantage have cumulatively funded 100+ startups in a short span of less than 2 years, and are poised to scale at 3-5x over the next 12-18 month period. Klub recently announced the first close of its INR 200 crore RBF fund Acceler8, while GetVantage and Klub last raised $5mn seed and $ 20mn Series A rounds respectively, to partake in the demonstrably widening Indian D2C and SaaS markets.

How does an RBF deal look?

RBF is offered by investors as a loan, and unlike traditional debt, repayments are variable and directly linked to the investee’s revenues.

• Repayments typically range between 5-10% of monthly revenues, and are required to be done until a fixed amount is repaid
• This fixed amount ranges from 1.05x-1.3x of the original principal, depending on the ticket size, tenor, company revenues, and growth potential
• Firms can raise between 1-4x of their monthly revenues, with the minimum monthly revenue requirement being Rs. 5 lakhs+

For example, assume Company A raises RBF of Rs. 30 Lakhs at a 6% fixed fee and 10% revenue share. Company A would then keep sharing 10% of its future revenue with the investor till it pays back a total of Rs 31.8 lakhs (Rs. 30 lakhs + 6%*30 lakhs).

Source: Velocity.in

This straightforward structure is also a key differentiator for Revenue-Based Financing. Funding raised via the RBF route is largely used for Marketing, Inventory Procurement, and Capex spends. Below is a quick comparison of the RBF offerings provided by key Indian players

Assessment of any business looking to raise RBF capital is done primarily on the strength of its marketing and revenue data. This data is shared in a digitally-integrated manner, enabling automated performance assessment and decisioning through a seamless underwriting process.

In summary, Revenue-Based Financing is a founder-friendly, frictionless, and performance-oriented form of growth capital, which is seeing increasing acceptance as it caters to a wide, latent market demand. If you are a business owner considering raising RBF capital, get in touch and we will be happy to assist you.